Home >Industry >Banking >RBI’s issues with non-banks stem from less control

In a country dominated by banks, non-banking financial companies (NBFCs), part of India’s shadow banking system have become very big over the last decade. This has created systemic risks which need to be taken more seriously. But, what are these risks? Mint takes a look.

How big have NBFCs become over 10 years?

Between 31 March 2009 and 31 March 2019, the total assets of NBFCs grew at 18.6% per year on an average, reaching 51.47 trillion, including assets of housing finance companies (HFCs). During the same period, the assets of banks grew at 10.7% per year. Most of this growth was financed through higher borrowing. As M. Rajeshwar Rao, deputy governor of the Reserve Bank of India (RBI), said in a recent speech: “NBFCs have been the largest net borrowers of funds from the financial system, of which, more than half of the funds were from banks, followed by mutual funds and insurance companies."

How much have NBFCs borrowed from banks?

The quantum of NBFC borrowings from lenders has grown substantially over the years. Between 31 March 2008 and 31 March 2020, banks’ lending to NBFCs jumped from 78,938 crore to over 8.07 trillion, growing at 21.4% per year. Banks’ lending to NBFCs picked up post March 2017, when it had stood at 3.91 trillion, and by March 2020, it had increased at the rate of 27.3% per year. One of the key drivers for this uptick was the government’s move to demonetize 500 and 1,000 bank notes in November 2016. In the aftermath, banks ended up with a lot of deposits which they weren’t able to lend out quickly.

Steady increase
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Steady increase

How did the non-banking financial firms fit in this?

For banks, NBFCs turned out to be a good way of bulk lending. Also, it is noteworthy that NBFCs borrow for the short-term, and lend for the long-term. This asset-liability mismatch gets them into trouble when their finances dry up, like it did in 2018-19, when big NBFCs, such as Infrastructure Leasing and Financial Services and Dewan Housing Finance Ltd got into trouble.

What happened after their finances ran dry?

Between 30 September 2018 and 31 March 2020, banks loaned more than 2.6 trillion to NBFCs, helping them ride their asset-liability mismatch. A lot of this money has been lent by NBFCs to the real estate sector, thereby increasing systemic risks. The sector has been treated with kids gloves in the recent past and, hence, there have been few defaults. But whenever the defaults surface, the trouble with NBFCs will end up spilling-over to banks and that’s clearly not good news.

What is the way out of looming NBFC woes?

As Rao put it: “By extension, the spill-over of risks from a systematically important NBFC capable of transmitting impact on financial stability, must be dealt with in a proportionate manner…Such [an] NBFC should have incentives either to convert into a commercial bank or scale down." This will mean more regulation for NBFCs, which are used to a regulation-light structure, something that has enabled them to expand at a very rapid pace.

Vivek Kaul is the author of Bad Money.

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